- Venture debt is a loan for fast-growing venture-backed startups that provides additional non-dilutive capital to support growth and operations until the next funding round. It’s often secured at the same time or soon after an equity raise.
- Venture debt can help reduce the cost of capital needed to fund operations and could be used as insurance against operational hiccups and unforeseen capital needs.
- Venture debt underwriting focuses less on cash flow and collateral and more on the borrower's ability to raise additional capital to fund growth and repay the debt.
Venture debt is widely discussed in startup circles but often misunderstood.
Venture debt is a catch-all term for loans designed to meet the unique needs of venture-backed startups in the innovation economy. It’s an attractive financing option for founders seeking to extend runway, lower their cost of capital and keep innovation thriving.
Venture debt funding can provide companies with three to nine months of additional capital without the same level of dilution as an equity raise. Though, importantly, venture debt is intended to supplement equity – not replace it. Founders often use this additional capital to accelerate growth, achieve milestones or cover costs until a next funding round. It could be used to hire or bolster a sales team, expand marketing, invest in research and development or buy capital equipment to get to commercialization and begin scaling.
SVB has provided venture debt to thousands of companies since venture debt was established over 20 years ago, and as one of the largest venture debt lenders, our name has become synonymous with venture debt.
Here, we’ve compiled a list of the 11 frequently asked questions we receive from companies across all stages and industries about venture debt:
1. What are the potential benefits of venture debt?
Venture debt benefits that many venture-backed startups experience include:
Access to capital – Provides a financing option for startups that may lack the cash flow or fixed assets, such a property and equipment, to qualify for a traditional bank loan.
Reduces the average cost of capital – Provides a competitive option for raising operational funds when a company is scaling quickly or burning cash.
Minimizes equity dilution – Since venture debt requires no equity, founders and employees retain more shares as their company grows.
Extends cash runway – Provides three to nine months of additional capital.
Provides flexibility and an insurance policy of sorts – Acts as a cash cushion against unforeseen capital needs, fundraising challenges or when things take longer than planned.
2. What makes venture debt different from other types of loans?
One major difference between venture debt deals and other loans is the underwriting. Unlike traditional loans, venture debt considers the equity raised by the company and focuses on the borrower's ability to raise further capital rather than cash flow.
Credit and debt available to commercial borrowers is underwritten based on the amount of cash flow they generate. Short-term advances are made against liquid assets such as accounts receivable and inventory until they convert to cash. These asset-based loans focus more on the collateral as the source of repayment instead of cash flow. Neither approach works for startups that are pre-product or recently began generating revenue.
The cash flow approach also doesn’t work well for revenue stage companies that consciously opt to maximize growth at the expense of profitability. Instead of focusing on historical cash flow or working capital assets as the source of repayment, venture debt emphasizes the borrower’s ability to raise additional capital to fund growth and repay the debt.
Read next: Learn more about how venture debt works
3. How much venture debt do I need?
A common measurement is a company’s venture debt-to-company valuation ratio, which typically hovers between 6 and 8 percent of a company’s last post-money valuation.
Read next: Learn more about the right amount of venture debt for your startup.
4. When is the right time (or wrong time) to raise venture debt?
When you are working on an equity term sheet, also initiate a conversation with a lender about venture debt. Typically, a venture debt loan is synced up to close a few months after a fresh round of equity such as a Series A or Series B. Raising debt when the company is flush with cash may seem counterintuitive, but in many cases the debt could be structured with an extended “draw period” so that the loan need not be funded right away. Regardless of when you want to draw from the loan, your creditworthiness and bargaining leverage are typically highest immediately after closing on new equity.
Conversely, soliciting venture debt when liquidity is diminished, and the operating runway is minimal, may prove more arduous and more expensive.
The venture industry is highly cyclical and venture debt availability is correlated to industry valuation trends. The availability of venture debt and the variety of loan structure options will expand and contract in response to venture capital trends, the direction of valuations in your sector and the broader economy. Think of yourself as the proverbial “umbrella shopper.” The best time to test the market is when there isn’t a cloud in the sky, and the worst time is when the storm is already lashing at your windows.
Read next: SVB’s innovation economy outlook: The State of the Markets report
5. What criteria do venture debt lenders use to underwrite?
Underwriting criteria are closely correlated to the applicant’s life stage and capital strategy.
- For early-stage companies with limited operating history, the focus is primarily on its investors, recent equity rounds and its projected cash burn rate. The amount of venture debt is generally calibrated to the size of the equity round, and the company’s current and projected cash burn rate. Companies with high burn rates are considered riskier borrowers because they’re even more dependent on external capital to “fuel the burn.” The lender will also assess the track record and the amount of committed capital each existing investor has in reserve for follow-on rounds.
- For later-stage companies, the ability to attract non-dilutive capital from new investors is a consideration when setting loan price and terms, as is a proven track record of hitting product development and financial milestones.
6. How do venture capital firms evaluate venture debt?
Venture investors generally appreciate the role venture debt plays in reducing the cost of capitalizing their portfolio companies. Some investors view drawn venture debt as a way of signaling expanded liquidity and increasing momentum – helping to attract customers, vendors and talent. Others view undrawn venture debt as useful insurance to hedge against performance blips or valuation hurdles. Still others like the notion of venture debt as “other people’s money” since it leverages their equity.
Regardless of their goals, experienced investors also understand that debt comes with trade-offs that need to be evaluated. Too much debt can create problems with next-round fundraising. Some new investors may balk at fresh equity being used to repay pre-existing debt. Financial covenants and tranched funding milestones also may limit a company’s strategic options and spending decisions.
7. How is venture debt priced?
A venture debt facility typically has three pricing components:
- The interest rate charged on the loan balance
- An origination fee
- Stock purchase warrants granted to the lender
The all-in cost varies significantly based on the lender’s assessment of the risk. Investors with an established track record and ample follow-on investment capacity compensate for the lack of company history and may help lower the cost of venture debt for early-stage companies. Later-stage companies that demonstrate exceptional growth and rapidly increase enterprise value are more attractive to lenders. Companies in sectors with binary risks such as regulatory oversight or unproven technologies tend to be less attractive.
Loan structure also influences the pricing. Loans with more structure – financial covenants, milestones that regulate loan draws or broader lien rights – are more aggressively priced because they reduce lender risk.
8. Is a venture debt deal available to seed-stage and pre-revenue companies?
Yes, but availability depends largely on the type of investors backing the company. The typical venture debt borrower is a fast-growth company that has raised money from venture capital firms, or similar institutional sources, as opposed to capital raised from “friends and family.” The borrower must have a defined strategy for continuing to raise capital. Many seed-stage companies will not align with this profile because of the composition of their investor base.
Venture debt lenders focus their underwriting on the probability and the capacity of the existing “inside” investors to close independently one or more follow-on rounds, should the company prove unable to attract new “outside” investors. Most seed investors fail to meet this standard either because they lack a committed capital base, or because they don’t intend to participate in follow-on rounds.
9. Who offers venture debt financing?
Most commercial banks do not offer venture debt. A few banks, including Silicon Valley Bank, specialize in working with innovation companies and their investors and consider venture debt to be a core product offering. SVB makes it easy to apply and close with a digital lending application and our Streamline Closing process. Learn more.
10. What are key considerations when selecting a venture debt lender?
When looking for a venture debt lender, it’s critical that you perform as much due diligence on your source of capital as they do on you. Some questions to ask yourself include:
- Are they known as a patient lender?
- Is their credit framework approved by regulatory bodies?
- How have they reacted in down cycles? Have they ever been tested by such a cycle?
Read next: Consider the ‘Four Cs of venture debt’ when choosing your lender
11. What is the biggest mistake founders make when taking on venture debt?
Many founders make the mistake of focusing their loan selection strictly on price and loan size. Instead, founders should focus on evaluating the lender. Strongly consider whether the lender has the credit appetite and a proven track record of working through challenges that many VC-backed companies face. It’s in your best interest to seek a partnership with someone who understands your business and the natural cycles of the innovation economy. It may make all the difference when unexpected things happen.
